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Why Did the Tech Bubble Correspond with Low Interest Rates?

Ultimately, our economy’s deeper problems aren’t so much a result of “money” as they are bad allocations of resources.

For context, read Bartlett’s article explaining the fall of SVB here.

I wanted to make a quick note about why tech bubbles tend to correspond with low interest rate environments. Interest rates essentially dictate how long someone can wait before they need to produce something of real value. In a 20% interest rate environment, it will be evident really quickly if you are failing to produce something of value. Since essentially 1/5 of your capital disappears each year, if you aren’t doing something that will generate real profits quickly, you are sunk. You can’t paper over problems with more borrowing because the cost of that borrowing is so high. Additionally, in such an environment, the payoffs for investment need to be large in order for someone to invest. No one is going to invest in something barely profitable if they can get a 20% return by just sticking their money in the bank.

When Borrowing is Free

However, in a low interest rate environment, both of these things switch. Businesses can run on fumes almost forever, and almost any reward at any time in the future is better than what the bank is paying. Therefore, people are more willing to do things that have high capital costs with payouts in the far future. Additionally, low interest rates mean that problematic ventures don’t get found out for quite some time. When borrowing money is almost free, it is easy to paper over problems by just borrowing more. The “cost of money” as it is called is practically zero. In the tech sector, you can always bamboozle people to say that your payday is coming “in the future,” as most investors are not able to separate truth from fiction.

When interest rates are low, payouts can be far in the future, which allows founders the freedom to over-glamorize (or just plain lie) about what that future will look like. It’s easy to have a “plan” for taking over the market in 20 years, as no one will notice that it isn’t working until 15 years in. It’s much harder to have a plan to take over the market in 2 years, as anyone will be able to catch the problems in near-real-time.

In short, low interest rates increase the gullibility of investors (since they are desperately looking for any yield, and are willing to accept longer timescales) as well as increase the abilities of management to simply paper over problems by simply borrowing more for free.

The Real Problem

In my opinion, raising interest rates itself is not actually the problem. Raising interest rates simply reveals the economic problems that were caused by having artificially low interest rates in the first place. The rising interest rates of the federal reserve didn’t so much cause the problems as it caused the problems to be known by the public. I am a fan of taking painful pills early before they become disasters. I think that the federal reserve’s actions in this case are an attempt to yet again avoid taking painful pills that may be necessary.

Ultimately, our economy’s deeper problems aren’t so much a result of “money” as they are bad allocations of resources. Low interest rates caused those allocations of societal resources to be mishandled. Raising interest rates is painful because it is forcing people to reallocate their resources in a dramatic manner. This is good for the economy in the long term, but extremely painful in the short term, and could have been largely avoided by accepting the pain much earlier on.

Jonathan Bartlett

Senior Fellow, Walter Bradley Center for Natural & Artificial Intelligence
Jonathan Bartlett is a senior software R&D engineer at Specialized Bicycle Components, where he focuses on solving problems that span multiple software teams. Previously he was a senior developer at ITX, where he developed applications for companies across the US. He also offers his time as the Director of The Blyth Institute, focusing on the interplay between mathematics, philosophy, engineering, and science. Jonathan is the author of several textbooks and edited volumes which have been used by universities as diverse as Princeton and DeVry.

Why Did the Tech Bubble Correspond with Low Interest Rates?